It is good for kids to wear costumes, this game helps them play the role of the character they are wearing; if he plays a doctor, the kid would imagine his is helping his toys, if he plays a teacher, he will teach his toys or if he is a magician, he will perform his tricks to the toys.
With costumes we contribute to children development, we encourage their creativity, their imagination and empathy (it is easier to understand other one feelings when we are able to be on their situation) and costumes help us with that. Kids enjoy creating situations and characters to play.
Costumes can also help us to understand how kids interact with the adults around them. We must look when kids play to be dad or mom, how the reproduce each of the behaviors over their toys or friends. If we analyze this, it can help us understand how the kids sense their parents or how they conduct.
Kids must know how to differ reality form their imagination. That´s why we will follow their lead as long as we are playing; but as soon as play time is over and the costume is off if they say they have a magic cape and they are flying through the kitchen we must stop them and make it clear the game is over.